Developed Economies Seen Fighting Off Emerging-Market Contagion

The pain will be limited to a few unbalanced economies -- including Turkey and Argentina -- with little heft abroad, and developed countries now have domestic sources of growth and support from central banks. Photographer: Jonathan Pozniak/Gallery Stock

Jan. 28 (Bloomberg) -- Emerging markets aren’t yet sneezing
enough for the rest of the world to catch a cold.

That’s the diagnosis of economists from Deutsche Bank AG to
Nomura International Plc after the stocks of developing nations
suffered their worst start to a year in five, raising concerns
they are turning from the driver of global growth to a drag.

The optimistic take is the pain will be limited to a few
unbalanced economies -- including Turkey and Argentina -- with
little heft abroad, and developed countries now have domestic
sources of growth and support from central banks. The risk is
that slowdowns and sell-offs deepen in bigger economies, such as
China, infecting the financial markets of industrial nations and
depriving them of demand for exports and commodities.

“We view the past week as more a warning” about what
could happen “should contagion become more entrenched and
broad-based across emerging markets,” said Jacques Cailloux,
chief European economist at Nomura in London.

The MSCI Emerging Markets Index is down 7.1 percent since
Dec. 31, compared with a 3.4 percent decline for the MSCI World
Index. Equity volatility in developing nations jumped the most
in two years last week amid a sell-off in their currencies, with
the Chicago Board Options Exchange Emerging Markets ETF
Volatility Index rising 40 percent to 28.26, according to data
compiled by Bloomberg.

World-Economy Engine

The threats posed by developing nations are attracting
debate, given these countries now account for almost 40 percent
of the world’s gross domestic product, up from 18 percent two
decades ago. They also served as the world economy’s engine when
the West was reeling from the financial crisis of 2008 and
subsequent recession and European debt woes.

“A broader emerging-market crisis today would come with
much greater ramifications” for growth worldwide, said Michala
Marcussen, global head of economics in London at Societe
Generale SA.

Even before last week’s tumult, the International Monetary
Fund estimated the growth gap between emerging and developed
economies is the smallest since 2001, and IHS Inc. calculated
the one-time locomotives would contribute the least this year to
worldwide expansion since 2010.

The concern is the rot lasts, adding a new challenge to a
still-fragile world, even though the global economy has changed
from the late 1990s -- when crises from Asia to Latin America
riled international markets -- and is stronger after the
financial turbulence of six years ago, said Holger Schmieding,
chief economist at Berenberg Bank in London.

Recession Recovery

The U.S. and U.K. are gathering strength, the euro region
has emerged from its own slump, and central banks continue to
keep interest rates at or near record lows.

Rich countries have escaped contagion before. When Asia was
roiled in the 1990s, U.S. growth topped 4 percent in 1997 and
1998, and the euro zone managed more than 2.5 percent expansion
each year. This means stress could be limited to countries with
high current-account deficits, political unrest or a reliance on
commodities.

Brazil, Indonesia, India, Turkey, Ukraine and South Africa
are among nations meeting some or all of these characteristics.
Argentina also falls in this category and began devaluing its
peso Jan. 22 in a bid to stem a financial crisis.

“By the standards of emerging-market crises, we do not
expect this to be a particularly bad one,” Schmieding said.

The outlook would change if turbulence became longer-lasting and more widespread. That would put the U.S. at risk,
because emerging markets now drive 15 percent of the sales of
companies in the Standard & Poor’s 500 Index, with China
accounting for a third of that percentage, according to Torsten
Slok, chief international economist in New York at Deutsche
Bank.

Reconsider Decision

Still, the U.S. domestic economy is improving, and it would
take a more-substantial stock-market decline for the Federal
Reserve to reconsider the plan it signaled in December to keep
cutting monthly asset purchases from an original $85 billion a
month.

“Our central expectation is while U.S. markets could take
a temporary hit, the shock will not be a major one for the U.S.
economy,” Slok said.

The S&P 500 is down 3.6 percent since Dec. 31 after rising
about 30 percent last year. GDP grew at a 4.1 percent annual
pace in the third quarter after expanding 1.1 percent and 2.5
percent in the first and second.

Cornerstone Macro LP also isn’t expecting the Fed to
respond to recent market volatility -- which some investors say
the central bank’s policies have exacerbated. Cornerstone
economists told clients yesterday the Fed will continue slowing
its quantitative easing after the Federal Open Market Committee
meeting this week, partly because officials ignore short-term
market fluctuations and don’t yet see a full-blown emerging-market meltdown on the horizon.

Isolated Difficulties

“There is a big difference between isolated severe
difficulties and a widespread crisis: The former don’t change
the outlook for the U.S. economy much, while the latter does,”
Cornerstone said. “For now, the Fed most likely thinks we are
in the former situation, so no course change is warranted.”

Similarly, Europe’s recovery likely would be impaired only
if a pervasive slowdown took hold in emerging markets, Nomura’s
Cailloux said. That’s even though the 18-country euro bloc has
been lifted by developing-nation demand in the last few years.

Nomura’s calculations show that a protracted slump in
Argentina, Brazil, Venezuela and Turkey would knock about 0.1
percentage point off euro-area growth, given they account for
about 3 percent of the region’s exports. Spain may be in greater
jeopardy because of its closer trade and banking ties with Latin
America.

Not Affected

“There’s no particular reason that Europe should be
affected by the problems encountered by a small number of
countries,” Bank of France Governor Christian Noyer said
yesterday.

Marcussen of Societe Generale cautions there still are
reasons to worry about the outlook for emerging nations, even
though they now boast more flexible currencies, stronger trade
positions, larger reserves and more-developed markets than in
previous decades.

China’s economy is the world’s second largest, and its
share of global GDP has jumped to 14 percent from 4 percent in
two decades, she said. That’s a problem if it struggles to
refocus demand toward domestic sources, especially after a
report last week showed manufacturing may contract for the first
time in six months.

Large imbalances and poor policy choices that drove past
crises also are prevalent in Argentina, Venezuela, Chile, Peru,
South Africa, Ukraine, Turkey and Thailand, she said. Add
Brazil, Indonesia, India and Russia, which have weak spots, and
13 percent of global GDP is in question, according to Marcussen.

China’s Role

The outlook ultimately may pivot on how China fares, said
Frederic Neumann, co-head of Asian economics research in Hong
Kong at HSBC Holdings Plc. The government is implementing the
biggest policy shifts since the 1990s and tackling debt-fueled
investment in a bid to generate more manageable growth based on
local rather than international demand.

HSBC still anticipates expansion of 7.4 percent there this
year after 2013’s 7.7 percent, adding the equivalent of
Switzerland or two Malaysias to the world economy.

While commodity producers such as Australia and Indonesia
may be hurt if China weakens more, the country has a current-account surplus and exchange reserves to prop itself up and
prevent a dive in the yuan.